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January 11, 2013

PIMCO’s El-Erian: How Would Market React to Trillion-Dollar Coin?

The move might shock politicians into cleaning up the fiscal mess, but the rest of the world may see it as inflationary, bond manager says

“The platinum coin option is, according to many experts, a perfectly legal way for the administration to preemptively remove the threat of another debt ceiling debacle in the next few weeks,” El-Erian begins, before briefly explaining conventional wisdom as to how it world work.

Under legal authority it already has (which is meant for decorative coins), the U.S. Treasury would issue to itself a very large platinum coin—say a single, trillion-dollar denomination, he writes. The coin would be deposited in the Treasury's account at the Federal Reserve. Against this "credit," the Treasury would withdraw from the central bank more conventional forms of money and use them to meet payment obligations that have already been approved by law.

“The key here is that the Treasury would raise money without borrowing. Thus, the increasingly binding debt limit would not apply; and congressional Republicans would be unable to hold the country hostage as happened just 18 months ago.”

How about the market implications, he rhetorically asks.

“I suspect that market reaction would be generally calm if the option were used as a way to diffuse what could otherwise be a repeat of the debt ceiling debacle in the summer of 2011—when political brinkmanship and bickering harmed growth, risk assets and the country's credit rating.”

It could also encourage Congress to deal once and for all with the oddity of having to consider both annual budgets and disconnected debt limits, he adds.

“In fact, there is a reason why this dual approach is not prevalent outside our borders,” he said. “It is both redundant and harmful.”

What if the coin approach was to prove an end in itself, he asks in a follow-up question?

“Markets would worry about whether the approach would add considerable fuel to the fires of congressional discontent, dysfunction and polarization. Political risk would increase, serving to price out an even greater array of job- and growth-enhancing investments by the private sector.

“It was not so long ago that sensible people would have deemed a platinum coin option as a laughable nonstarter,” he wrote. “The fact that it is being now discussed so widely speaks loudly to the mess Congress has gotten itself (and the country) in.”

“The best way forward for everyone is for Congress to change the way it is currently handling its important economic responsibilities. Should this fail to occur, options such as the platinum coin will garner lots of attention in the months and years ahead.

“It would be a loss for all, domestically and around the world, if the unthinkable becomes the only operational approach for the U.S. In the process, congressional approval ratings would also dip below 10%, raising uncomfortable questions about the current state of our representative democracy.”